The institution warns that the government may struggle to deliver promised improvements in education, health and transport if inflation in the construction sector continues to rise at its present rate. Costs have been rising at an average of 4% for the past four years.
It cites "cost-push" factors, particularly chronic labour shortages, as the main cause of rising costs, and notes that construction wages are ahead of those in other sectors.
The report says the industry has been hit by a shortage of skilled workers across all trades as it is still trying to recover from the recession of the early 1990s when many left the industry.
Output fell 12.8% between 1990 and 1993 before recovering in 1995, whereas employment levels fell 28% between 1991 and 1996 and only started to improve in 1997. This has caused labour costs to rise steadily since 1996 (see graph, right).
Construction output has now hit a 12-year high, but the sector employs 20% less workers than in 1990. The report adds that this rise in output has been steady compared with 1990 when it "ultimately proved to be unsustainable".
The report says: "The extent of the fall [in employment levels] meant that many skilled labourers and professionals left the industry, leaving behind the problem of skills shortages as a key characteristic of the industry."
The report notes that the projected slowdown in construction output over the next year will help ease some labour shortages. Materials costs, although also rising, are increasing more slowly.
The report also found that the commercial property market was slowly showing signs of recovery after a year of falling demand for office space, but it says there are no indications that it will achieve the activity experienced in 1999 and 2000.
Commercial property was hit by the drop in business confidence after the events of 11 September. Several projects have been shelved or delayed.
The RICS adds that projects postponed because of economic uncertainty are likely to be revived later this year and next.
The report says the London office market continued to be weak because of continuing difficulties in the financial and banking sectors.